ADVANCE AUTO PARTS INC 2026 Q2 Earnings Call

Good morning and thank you for participating in today's call. I am joined by Shane O'Kelly, President and Chief Executive Officer, and Ryan Grimsland, Executive Vice President and Chief Financial Officer. During today's call, we will be referencing slides, which have been posted to our investor relations website. Before we begin, please be advised that management's remarks today will contain forward-looking statements. All statements other than statements of historical fact are forward-looking statements, including but not limited to statements regarding initiatives, plans, projections, goals, guidance, and expectations for the future. Actual results could differ materially from those projected or implied by the forward-looking statements. Additional information can be found under forward-looking statements in our earnings release and risk factors in our most recent Form 10-K and subsequent filings made with the SEC. Shane will begin today's call with an update on the business and progress on our strategic priorities for 2026.

Later, Ryan will discuss results for the second quarter and provide an update on the guidance for full year 2026. Following management's prepared remarks, we will open the line for questions. Now, let me turn over the call to our CEO, Shane O'Kelly.

Shane? Thank you, Lavesh, and good morning, everyone.

I would like to start by expressing my appreciation for our frontline team for their hard work and dedication to serving our customers. During the second quarter, the team navigated a volatile demand environment, which contributed to a slight decline in comparable sales. This included low single-digit sales growth in the Pro channel, which performed in line with our expectations. Within Pro, the Main Street business continued to outpace overall growth, supporting share gains in that segment. In the DIY channel, sales declined more than we anticipated, particularly during the last four weeks, as tighter household budgets weighed on consumer spending during the quarter. Against this backdrop, the Advance team continued to prioritize actions across our strategic initiatives, which contributed to solid profitability in Q2 with an adjusted operating margin of 5.6%.

Excluding the benefit of IEEPA refunds received in the quarter, adjusted operating income margin expanded by nearly 130 basis points to 4.3%. We maintained focus on executing actions within our control, which has translated to sequential improvement in core operational KPIs, including NPS, time to serve, and attachment rates. The second quarter marked an inflection point for Advance with a return to positive free cash flow as we generated $120 million year to date compared to an outflow of cash during the last two years. During the quarter, we also repurchased approximately $30 million of outstanding debt, which along with improved profitability, supported further de-leveraging of the balance sheet while we continued to allocate more capital to investments to grow the business.

Based on our first half performance and updated projections for the remainder of the year, we are reaffirming our full year sales, operating margin, and free cash flow guidance. This includes comparable sales growth in the 1%-2% range, which considers continued spending pressure in the DIY channel, offset by ongoing strength in the Pro channel, along with higher same-SKU inflation due to increased commodity costs. We are also implementing a focused action plan aimed at strengthening execution across our operational KPIs and driving higher customer engagement to deliver better transaction performance in the second half compared to trends during Q2. Our margin outlook balances the tailwind from recent tariff refunds with incremental headwinds stemming from shifts in channel mix and increased commodity costs. We will continue to prioritize efforts to make progress on our strategic objectives as we work to create long-term value for our shareholders.

Let's turn to an update on our strategic priorities for 2026. Our strategy remains unchanged and is built on three pillars, merchandising, supply chain, and store operations, supported by targeted initiatives to drive sustainable, profitable growth over the long term. We remain committed to executing actions under our 2026 strategic priorities as we make progress on our journey towards a medium-term 7% adjusted operating margin target. Let's begin with merchandising. We are focused on ensuring reliable product availability, which supports the efforts of our store team to enhance customer service and drive growth in unit sales per transaction. Our new assortment framework, launched last year, is helping us increase the breadth of products we carry in each store and broadening availability across our network of DCs, hubs, and stores.

Halfway through this year, we have added approximately 80,000 new SKUs to our assortment catalog, building upon the 100,000 new SKUs we introduced last year. Through comprehensive category reviews, we are strengthening relationships with existing vendors and identifying opportunities to improve margins, while also partnering with new vendors to further expand our selection of parts. In the near term, our merchandising team is refining communication within the DIY channel to enhance brand awareness and deliver value-driven offerings aimed at increasing customer engagement. We are collaborating with vendors on targeted media campaigns, leveraging Advance Rewards, providing store incentives, and optimizing online paid search to stimulate transaction growth and improve conversion in stores. Moving to an update regarding our pricing and promotions management initiatives. We are on schedule to complete the full deployment of a new pricing framework for both DIY and Pro segments by year end. Our pricing philosophy remains unchanged.

We aim to offer everyday competitive prices and operate rationally in the market. The new framework is expected to enhance visibility of competitive pricing actions and enables the execution of precise market-based pricing strategies. The early results from the Pro channel have shown an increase in team member and customer confidence, which we expect to support efforts to grow share among Main Street Pros. Alongside the implementation of more sophisticated pricing models, we are also improving discipline around the management of store-based promotional activities. We expect to offer everyday competitive prices along with seasonally relevant promotions and plan to deploy marketing dollars on offers that yield an improvement in sales or profitability. On a year-to-date basis, our merchandising initiatives have contributed approximately 100 basis points to product margin expansion.

We anticipate building upon this growth in the second half of the year to support our margin improvement goals for the year. Turning to supply chain. In the second quarter, we completed our distribution center consolidation. This initiative commenced more than two years ago when we operated nearly 40 DCs across the U.S. utilizing multiple warehouse management systems. As of today, we operate 15 DCs supported by a unified warehouse system, marking a key milestone in our efforts to enhance asset productivity throughout our supply chain. Along with consolidating our DC network, we also launched market hubs that improve same-day parts availability for our customers. Areas equipped with market hub locations consistently outperform those without market hubs, which reaffirms the strategic value of these locations. Year to date, we have opened five market hubs, bringing the total to 38 locations.

Our real estate team has done a great job in expanding our capabilities, and I am pleased to share that we are accelerating the pace of market hub openings for this year. We now plan to open 15-20 market hub locations this year and remain on track to achieve our goal of operating 60 locations by mid-2027. Regarding DC productivity, our team is concentrating on key process improvements aimed at streamlining and standardizing operations within our distribution centers. We anticipate that these actions will yield greater operational efficiency and facilitate improved product flow into and out of the DCs. During the second quarter, we completed 25% of the identified process improvements and remain on track to systematically implement the remaining process changes by mid-2027.

These actions are aimed at increasing labor productivity within our DCs and provide visibility into cost reductions per unit shipped, which is expected to contribute to margin expansion starting next year. Our strategy is focused on minimizing redundant product handling, improving shipment accuracy, reducing inventory lead times, and transitioning to a more variable cost structure. For example, we have now standardized the DC receiving process across our facilities, eliminating a significant number of variations, which is expected to deliver better productivity through higher processing volumes per labor hour. Another critical component of supply chain productivity is transportation optimization. We are currently rebidding all of our carrier contracts, and we expect to consolidate our volume with 70% fewer carriers. This initiative is expected to generate tens of millions of dollars in cost savings, which will support margin expansion in 2027.

Collectively, the DC process changes and transportation initiatives are expected to enhance our ability to operate a more efficient and scalable supply chain. Next, I will conclude with an update on our third strategic pillar, store operations. In our stores, we are holding teams accountable for service execution and measuring the effectiveness of our initiatives through clearly identified KPIs as we strive to increase labor utilization. The second quarter provided further evidence of progress on our store-based initiatives. NPS, or Net Promoter Scores, have improved to nearly 80 points from the high 60-point range in the same period last year, which suggests that our service enhancements are resonating with customers. In-store attachment rates have improved to nearly 30% from the mid-high 20% range in the same period last year, which contributes to unit share gains.